SAN DIEGO—California markets are dealing with many of the same issues in regard to their office sectors, including a preference for collaborative space, urban environments and lots of amenities, but are they each prepared for the future of this sector? GlobeSt.com spoke with JLL office experts in four California markets—Bess Wakeman, EVP in San Diego; Jeff Ingham, senior managing director in Orange County; Josh Wrobel, managing director in Los Angeles; and Wes Powell, international director in San Francisco—to find out how well office supply is being controlled in each market. Stay tuned for part 2, which discusses what the pipeline looks like for development in each of the four markets.

GlobeSt.com: How is your market positioned for what lies ahead in the San Diego office sector?

Wakeman: During the most recent downturn, we saw a “flight to quality,” whereby tenants were willing to relocate because they could upgrade their address and, in many cases, pay less than what they were currently paying. Now, we are starting to see a “flight to value.” Tenants are seeking to find the balance between rental rates and the building quality, amenities and location that are commensurate with a particular rate. Although, by comparison to other waterfront markets like San Francisco and Seattle, San Diego remains a bargain, and tenant activity remains robust. To attract tenants, proactive landlords, of which there are many, have been reinvesting in their assets to keep them competitive with their peers and sought after by tenants.

Ingham: The Orange County office market is well-positioned as the market continues to evolve. It is becoming increasingly popular to compare the current state of the market to the previous cycle; however, it is important to understand the different conditions between them. The last time Orange County had asking rents and vacancy rates similar to the current market in 2007, there was 1.2 million square feet of vacant sublease space, compared to 566,000 square feet in Q1 of this year. According to the California EDD, the local economy had a total nonfarm employment base of 1,521,400, while the current workforce totals 1,589,600. Back then, Orange County lost 9,900 jobs during the previous 12 months, compared to now when the economy added 23,300 jobs. During the last cycle, the local economy was heavily influenced by the financial services sector, specifically, the mortgage industry. Current economic growth is being led by a diverse set of industries, including healthcare, technology, life sciences and business services. Industries such as healthcare contribute to market expansion not only directly, but also indirectly since firms that provide services to healthcare companies expand operations as well. A more diversified economy positively impacts the commercial real estate market as more companies seek space for their operations, thus also contributing to job growth. Instead of relying on one industry to lease space and produce jobs, Orange County's economy has a stronger foundational base than the previous cycle.

Wrobel: The Los Angeles basin marketplace sits on an extremely strong foundation as the principles of supply and demand favor Los Angeles as a further tightening marketplace. Tenant demand has largely originated the media, entertainment and technology industries driving the majority of the more-than-7-million square feet of positive absorption in the Los Angeles basin over the past five years. From a supply perspective, the current Los Angeles development pipeline of just over 2 million square feet of new supply (which represents ~1% of the class-A and class-B total square footage) ranks Los Angeles as the 18^th market in the nation on a total-square-footage-under-construction basis. As any economics professor will tell you, if you advance down a path of high demand, limited supply and substantively concentrated ownership, one can expect to see market rates that continue to push upward (which would prolong the trend of strong annual rate growth over the past few years).

Powell: The San Francisco office market remains well positioned. San Francisco has risen to become a global world-class city in the last 10 years, and that's reflected in our rents as well as the companies that want to have a presence in this market and the capital that has a desire to invest here. Our traditional Downtown office markets will be supplemented over the next 10 years with new development in emerging commercial “outlying” areas like Central SOMA, for which the city of San Francisco has an extensive redevelopment plan, as well as around major new transit hubs, such as the Transbay Transit Center now under development on Fremont Street. Absent unknown global events like the 2008 financial crisis, I believe that the market has more room to succeed.

GlobeSt.com: How well is office supply being controlled in your market?

Wakeman: San Diego developers have been extremely controlled over the past few years with respect to development. Their disciplined approach has led to little, if any, 100% speculative office development. You can pretty much count on one hand the multi-tenant spec development occurring in San Diego. Most notably, we've seen Irvine Co. in UTC and Kilroy Realty in Del Mar Heights both build spec product in the last 24 months, and both of those assets are now approximately 67% leased. Additionally, Kilroy is moving forward with the large-scale mixed-use development called One Paseo in Del Mar Heights, which will bring an additional 280,000 rentable square feet of spec development along with multifamily and retail to that submarket in late 2018/early 2019.

The renaissance taking place Downtown has been a top story for San Diego for the past couple of years due to the multifamily boom, popularity from the millennial workforce and an upswing in startups—more than 110 and counting—opening their doors in Downtown. All of these influences have contributed to the current class-A direct vacancy rate of 8.1%. However, what has also significantly aided this tight vacancy is the lack of new construction. The 100%-preleased build-to-suit corporate headquarters for Sempra Energy in Downtown's East Village, which delivered in 2015, was the first office construction to hit Downtown since DiamondView Tower delivered in 2007.

Ingham: There has only been 1.1 million square feet of new speculative development delivered to the market since 2012. Much of the space was pre-leased or leased upon completion to several tenants, including Mazda, Cavium and AutoGravity. New construction completions are placing upward pressure on overall average rents, while balancing market vacancy at equilibrium.

Wrobel: Even in a market that has reached peak rates in certain submarkets, overall supply in Los Angeles is relatively throttled in comparison to other national markets. Supply (or even re-supply in the form of redevelopment of older projects) in Los Angeles tends to be held in check by a number of factors including the increasing value and competition for land (due to the increase in demand in the residential/hospitality sectors), the rising costs of construction, local submarkets that tend to discourage new development and over-crowding and the general aging of a great portion of the Los Angeles office product (very little of which was built in the last two decades).

Powell: Sublease activity has been very active for the past four quarters. This is taking a large share of some of the active requirements off the market, especially when the space being offered is nice and ready for move-in. We have a very low sublease vacancy despite the volume of activity: overall sublease vacancy remains below 2% (currently approximately 1.7%). We generally see the sublease market vacancy at about 2% to 3% of total inventory in a healthy market—when it rises to 4% to 6%, that's bad for landlords and rates. So, sublease inventory is low despite the volume, and is well in line with historical norms. Overall demand remains strong. We're continuing to see large requirements in the market—we're tracking about 7 million square feet of total requirements right now—and there were six transactions greater than 100,000 square feet in the first quarter. We expect this trend to continue partly because we didn't see a lot of big-block transactions in 2016. Supply is currently in balance with a low vacancy, good activity and a market that can meet most every requirement. San Francisco will likely face shortages of large blocks of space in 2018 thru 2021.

GlobeSt.com: How is your market positioned for what lies ahead in the San Diego office sector?

GlobeSt.com: How well is office supply being controlled in your market?

Instant Insights /

How CA Office Markets Are Positioned for What Lies Ahead

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